The Gold Exchange and The Bretton Woods Agreement
The Gold Exchange and The Bretton Woods Agreement
The Gold Exchange and The Bretton Woods Agreement
In 1967, a Chicago bank refused a college professor by the name of Milton Friedman a
loan in pound sterling because he had intended to use the funds to short the British
currency. Friedman, who had perceived sterling to be priced too high against the dollar,
wanted to sell the currency, then later buy it back to repay the bank after the currency
declined, thus pocketing a quick profit. The bank’s refusal to grant the loan was due to
the Bretton Woods Agreement, established twenty years earlier, which fixed national
currencies against the dollar, and set the dollar at a rate of $35 per ounce of gold.
But the gold exchange standard didn’t lack faults. As an economy strengthened, it
would import heavily from abroad until it ran down its gold reserves required to back its
money; consequently, the money supply would shrink, interest rates rose and economic
activity slowed to the extent of recession. Ultimately, prices of goods had hit bottom,
appearing attractive to other nations, who would rush into buying sprees that injected
the economy with gold until it increased its money supply, and drive down interest rates
and recreate wealth into the economy. Such boom-bust patterns prevailed throughout
the gold standard until the outbreak of World War I interrupted trade flows and the
free movement of gold.
After the Wars, the Bretton Woods Agreement was founded, where participating
countries agreed to try and maintain the value of their currency with a narrow margin
against the dollar and a corresponding rate of gold as needed. Countries were
prohibited from devaluing their currencies to their trade advantage and were only
allowed to do so for devaluations of less than 10%. Into the 1950s, the ever-expanding
volume of international trade led to massive movements of capital generated by post-
war construction. That destabilized foreign exchange rates as setup in Bretton Woods.
The Agreement was finally abandoned in 1971, and the US dollar would no longer be
convertible into gold. By 1973, currencies of major industrialized nations floated more
freely, as they were controlled mainly by the forces of supply and demand. Prices were
floated daily, with volumes, speed and price volatility all increasing throughout the
1970s, giving rise to new financial instruments, market deregulation and trade
liberalization.
In the 1980s, cross-border capital movements accelerated with the advent of computers
and technology, extending market continuum through Asian, European and American
time zones. Transactions in foreign exchange rocketed from about $70 billion a day in
the 1980s, to more than $1.5 trillion a day two decades later.
A major catalyst to the acceleration of Forex trading was the rapid development of the
eurodollar market; where US dollars are deposited in banks outside the US. Similarly,
Euromarkets are those where assets are deposited outside the currency of origin. The
Eurodollar market first came into being in the 1950s when Russia’s oil revenue-- all in
dollars -- was deposited outside the US in fear of being frozen by US regulators. That
gave rise to a vast offshore pool of dollars outside the control of US authorities. The US
government imposed laws to restrict dollar lending to foreigners. Euromarkets were
particularly attractive because they had far less regulations and offered higher yields.
From the late 1980s onwards, US companies began to borrow offshore, finding
Euromarkets a beneficial center for holding excess liquidity, providing short-term loans
and financing imports and exports.
London was, and remains the principal offshore market. In the 1980s, it became the key
center in the Eurodollar market when British banks began lending dollars as an
alternative to pounds in order to maintain their leading position in global finance.
London’s convenient geographical location (operating during Asian and American
markets) is also instrumental in preserving its dominance in the Euromarket.